Ricardian Flashcards
How are countries different in Ricardian?
Different labour productivity
What is the opportunity cost of good A in terms of good B?
The number of units of good B that have to be given up to produce an additional unit of Good A.
A country has a comparative advantage in good A if…
It has a LOWER opportunity cost if good A in terms of good B compared to another country.
How can we show that trade based on comparative advantage is beendifical?
Global production rises - can produce more goods with the same resources as each country specialising means these goods are produced more efficiently.
Background on David Ricardo and why he came up with the model.
1817
1851 Corn laws - Ricardo wanted to show that tariffs on grain imports into UK were bad
Hence he made uk look, as weak as possible and still showed Trade is beneficial.
What determines comparative advantage in Ricardian model?
Different labour productivity across countries
Dimensions of Ricardian model
2-2-1
2 countries, 2 goods, 1 FOP = labour
Labour mobility assumptions (2)
- Labour mobile across industries
2. Labour immobile across countries
Assumption about market structures
Perfect competition since Ricardian is a neoclassical model
Unit labour requirement shows…
How many units of labour are needed to produce 1 unit f output?
What do unit labour requirmenrs imply about return to scale?
CRS - if we want to double output, must double inputs
How do unit labour requirements relate to labour productivity?
INVERSE of productivity - lower labour unit requirements = higher productivity
PPF shows
The maximum amount f a good that can be produced for any amount f ten other good.
PPF equation
aLW Qw + aLC Qc = L
Slope of PPF equals
Opportunity cost of cloth in terms of wine
= aLC / aLW
Optimum production depends on (2)….
- PPF - what an economy is able to produce
2. Relative prices
Relative price of cloth in terms of wine =
PC/Pw
- the amount of wine that can be exchanged I; the market for one unit of cloth
Relationship between wages across industries and why
Ww = Wc = W
Due to labour mobility across industries —> arbitrage
What is MC formula?
MC = labour unit requirement x wage
- the wage cost to produce an extra unit of output
2 conditions that need to be satisfied under perfect competition for an economy to produce both goods.
- Pc = aLC x Wc
2. Pw = aLW x Ww
Optimality condition in Autarky
Pc/Pw = aLC/aLW
Relative price of cloth = opportunity cost of cloth
If PC/PW > aLC/aLW an economy t will…
Produce cloth only
If PC/PW < aLC/aLW an economy will…
Produce wine only
Define absolute advantage
Absolute adv = an economy has a lower labour unit requirement in that good compared to another country’s labour unit requirement in the same good.
I,e, more efficient at producing that good.
Is trade beneficial is one country has an absolute adv in both goodS.
YES - Trade us based on comparative advnateb
What do we compare between home and foreign to determine comp adv?
aLC/aLW vs aLC/aLW
What happens to relaorbr priced after trade?
We have ONE WORLD RELATIVE PRICE in between the 2 pre trade domestic prices. Hence relative priced equalise across countries.
What do the shapes of world RD and RS look like?
RD = we assume standard downwards sloping demand RS = a step function
Production is world relative price < both opportunity costs
NO cloth produced - wine only.
Production if world relative price = home opp cost, but < foreign opp cost.
Home indifferent between cloth and wine = produce some combo of the two.
Foreign still produces wine only.
Production if: home opp cost < world relative price < foreign opp cost.
Zone of complete specialisation
- Home produces cloth only
- Foreign produces wine only
Any price between the two lead to same quantity as all resources devoted to one good in each country.
Production if: Home opp cost < world relative price = foreign opp
Home specialise in cloth
Foreign indifferent between the 2
Production if: home & foreign opp costs < world relative price
Home and foreign produce cloth only - NO WINE.
The gains from trade can be either show by (2)….
- Production side gains
2. Consumption side gains
How do we show production side gains from trade?
No trade: show output esch country can produce of the good it does not have a comp adv in using 1 hr labour.
Trade: show how much of comp adv good can be produce using 1 hr labour, then how much of the other good we get through trade.
Qc x Pc/Pw = Qw
Qw x Pw/Pc = Qc
The CPF shows
The maximum amount of a good that can be consumed for a given amou;t of the other good.
How do PPF and CPF relate in Autarky?
PPF=CPF - can only consume what u produce in aukarky.
In what extreme case is trade NOT beneficial consumption wise?
If a country only wants to consume the good it has a comparative advantage in, trade —> NO expansion of CPF here
Do we see wages equalising across countries? Why? Why not?
NO - w and w* NOT EQUAL
due to labour immobility across countries assumption
W > W* IF…
If home has an absolute advantage in BOTH goods, it will have a higher wage. (Before & after trade)
But if neither country has an absolute adv in BOTH goods, ambiguous.
Formula for wages under perfect competition
P = MC
MC = aLC x Wc
Wc = Pc/aLC
or Ww = Pw/aLW since Wc=Ww
How does Ricardian response to myth 1 that trade is only beneficial for strong countries?
Trade depends on comparative, not absolute adv.
A country with an absolute disadvantage in both goods can still benefit from trade.
How does Ricardian respond to myth 2 the Pauper labour argument?
Wages based on domestic labour productivity. Ricardian does not predict wage equalisation from trade. And only 1 FOP so no income inequality implications.
- But Trade enlarges CPF so purchasing power rises.
How does Ricardian respond to myth 3 exploitation argument?
trade enlarges CPF and so increases purchasing power.
Denying opp to trade —> worse outcomes.
The Q is not whether they should be paid more, just whether trade makes them better or worse off.
Does the empirical evidence support Ricardian prediction on labour productivity and wages?
YES - cross sectional and Time series evidenc of higher productivity = higher wages.
Does empirical evidence support Ricardian that trade is based on differing labour productiviies?
YES - higher US/British productivity —> higher US/British exports
How does adding transport costs affect the Ricardian model?
Transport costs —> some goods NONTRADED e.gl services like haircuts.
